Metropolitan Health Networks: Too Reliant on One Big Customer?

| About: Humana Inc. (HUM)

Metropolitan Health Networks (MDF) operates medical practices in order to provide health services to medicare customers in the State of Florida. Its largest customer, Humana (NYSE:HUM), accounts for between 99.2% and 99.6% of its revenues, with the remainder coming from Fee-for-Service customers. Humana receives payment from medicare customers and from the United States Department of Health and Human Services, and then outsources the hands-on medical service to MDF.

When a company has a high reliance on a single customer, such as MDF’s reliance on Humana, an investor has to be extremely certain that the customer will continue to purchase from the company. Often, we will look for contracts that would reassure us that the business will continue. In MDF’s case, the contracts that form the arrangement between Humana and MDF fail to provide much reassurance for investors and leave Humana many outs. From the recent 10-Q:

The Humana Agreements and/or any individual physician in our primary care physician network may be immediately terminated by Humana, upon written notice, (i) if the PSN and/or any of the PSN physician’s continued participation may adversely affect the health, safety or welfare of any Humana customer or bring Humana into disrepute; (ii) if the PSN or any of its physicians fail to meet Humana’s credentialing or re-credentialing criteria; (iii) if the PSN or any of its physicians is excluded from participation in any federal healthcare program; (iv) if the PSN or any of its physicians engages in or acquiesces to any act of bankruptcy, receivership or reorganization; or (v) if Humana loses its authority to do business in total or as to any limited segment or business (but only to that segment). The PSN and Humana may also terminate two of the Humana Agreements covering a total of 25,400 customers upon 90 days’ prior written notice (with a 60 day opportunity to cure, if possible) in the event of the other’s material breach of the applicable Humana Agreement. These agreements may also be terminated upon 180 day notice of non-renewal by either party. The third Humana Agreement covering 9,200 customers has a five-year term expiring August 31, 2013 and will renew automatically for additional one-year periods upon the expiration of the initial term and each renewal term unless terminated upon 90 days notice prior to the end of the applicable term. After the initial five-year term, either party may terminate the agreement without cause by providing to the other party 120 days prior notice.

Though the company looks attractive, and has certainly experienced strong growth and solid free cash flows, the risk of the contracts not being renewed, or cancelled due to one of the bold terms above (which seem vague to me – “disrepute” or “harming a Humana customer”) are too great for me. The margin of safety would have to be large enough to sustain a loss of a customer that accounts for 99%+ of its revenues – I doubt we’ll see this anytime soon!

Author Disclosure: No position.